Cyprus: The E.U. ‘Rescue’ That Risks Backfiring

With its $13 billion agreement to bail out Cyprus, the E.U. this weekend thought that it had successfully doused the latest threat to its single currency, the euro. Cyprus has run into trouble because its banks are heavily exposed to Greek debt. Instead, the nature of the bailout – which features a levy on the bank deposits of ordinary Cypriots — has sparked a bank run on the island that threatens to spill over to other European countries.

The sudden eruption of panic could still be contained; European officials on Sunday night were looking to revise the terms of the agreement ahead of a vote on the rescue package in the Cypriot parliament, in order to shield smaller depositors. E.U. officials insist that Cyprus was always a special case. But by forcing ordinary citizens to fund the bank rescues up front, through a tax on deposits, the E.U. is setting a precedent that is chilling to people in other countries, like Spain, which has looked at a bailout for its own beleaguered banking system.

In an impassioned address on Cyprus TV on Sunday night, President Nicos Anastasiades said, “Cyprus is in a tragic situation,” but he argued that this rescue package was the best one for the island nation. “I chose the least painful option, and I bear the political cost for this, in order to limit as much as possible the consequences for the economy and for our fellow Cypriots,” he said.

The $13 billion bailout package may seem like chump change, but in fact it represents about 50% of Cyprus’ total economy. The Cypriot central-bank governor, Panicos Demetriades, has pointed out that, as a proportion of GDP, it is one of the largest bank bailouts ever, second only to the 1997 bank bailout in Indonesia.

The government first requested a bailout in June 2012 after the two biggest banks, Laiki Bank and Bank of Cyprus, racked up huge losses on their exposure to Greek debt and themselves needed to be rescued. The sticking point for E.U. officials, and especially for the German government, has long been Cyprus’ status as a haven for Russian money, at least some of which is widely assumed to be of dubious origin. The German national intelligence agency in November reportedly found that Russians had deposited as much as $26 billion in the island’s banks, prompting government fears that E.U. bailout funds would simply disappear into a bottomless pit of corruption.

At the insistence of both the E.U. and the IMF, Cyprus would only receive a bailout if as much as $6 billion of the money could be recouped from bank depositors. That solution was aimed primarily at the Russians and other wealthy depositors, with more than $130,000 in their accounts. But under the terms of the agreement finalized on Friday night, all depositors will take a hit. A one-time levy of 9.9% will be charged on deposits over $130,000, and accounts with less will be charged 6.75%.

Monday happens to be a bank holiday in Cyprus, so the agreement was supposed to take effect on Tuesday, following a vote by the Cyprus parliament. Electronic bank transfers were suspended and ATM withdrawals were limited — but even so the cash machines quickly ran dry as ordinary Cypriots rushed to withdraw as much money as they could.

The parliamentary vote, slated for Sunday, was postponed, and now looks like being a critical moment for the island’s politics: President Anastasiades’ party has only 20 of the 56 seats in parliament. In his TV address on Sunday, he insisted that he was seeking to strike a revised and more favorable deal for small depositors. But opposition leaders are rejecting the deal. All in all, it’s a volatile mix that looks sure to rattle markets around the world until the situation is resolved.

Peter Gumbel writes about European business and finance from Paris, where he has lived since 2002. He was worked as a staff writer for The Wall Street Journal, TIME and Fortune. The London-based Work Foundation named him "Journalist of the Year" in 2005.

Gumbel's latest book is France's Got Talent: the woeful consequences of French elitism. A digital version is available in English.

I agree with AngelaWalker. This is a test and we should voice opposition to it. If the Cyprus government needs to tax assets they should start with the banking/financial industry leaders and the watchdogs who are supposed to prevent these poor banking practices.

I get paid over $87 per hour working from home with 2 kids at home. I never thought I'd be able to do it but my best friend earns over 10k a month doing this and she convinced me to try. The potential with this is endless. Heres what I've been doing, Great60.comCHECK IT OUT

So as a foreigner, I lose faith in Cyprus, which once I thought was heaven .. and I wrote about it. Why do the manipulators eat away money of the innocent investors ? It happened to provident funds in Russia. It is happening in Cyprus .. May be Cyprus has become a tax hell instead of its being a tax haven.